Because many early-stage life sciences companies do not yet have revenue, valuing them has always been challenging. These challenges have been amplified by the spotlight put on the industry by the pandemic, historically high public and private market volatility, and economy-wide uncertainty caused by macroeconomic factors including, but not limited to, the war in Ukraine, high levels of inflation, rising interest rates, lingering supply chain disruptions, staffing shortages, and the potential for a recession. These complications don’t change the fact that management teams of early-stage life sciences companies still need to have reasonable, supportable estimates of company value, whether it be for raising capital, issuing shares and/or options to employees, or a host of other reasons. This article examines how current market conditions affect value conclusions and how management can maximize their company’s valuation.
Management obviously can’t control market volatility, interest rate levels, the overall receptiveness of public markets, other macroeconomic factors, or the effect each has on value. Unfortunately for life sciences companies, these factors have generally exerted downward pressure on valuations in 2022. After a record level of IPOs in 2021, the IPO and follow-on windows for life sciences companies have effectively closed in 2022. M&A activity in life sciences has also decreased significantly in 2022, further reducing the industry’s access to capital and pushing down valuations. With recent increases in interest rates, the capital that is available has become more expensive. Life sciences companies also face the operational challenges currently faced by most industries resulting from a shortfall of available talent for vital roles within the company.
There are some bright spots for the industry, though. Venture financing for very early-stage companies remains strong as investors are confident in the long-term viability of the industry. The necessity of responding quickly and effectively to the worldwide threat of COVID-19 resulted in a dramatic increase in scientific and regulatory collaborations, an accelerated pace of innovation, the adoption of new technologies (both product related and process related), improvements in supply chain and inventory management, and manufacturing efficiencies. The industry has also long embraced the virtual work environment, particularly for the earliest stage companies, so it is largely escaping the employer/employee friction of “back to the office” policies being increasingly implemented in other industries.
Investors are aware of these bright spots, and valuations are still generally down, so what can companies do to maximize their valuation? The answer is relatively simple – remove uncertainty. Regardless of the industry, uncertainty equals risk and investors require compensation for taking on risk. For equity investors, that compensation comes in the form of a higher expected return resulting from a lower pre-money valuation at the time of investment. Because management can’t remove the uncertainties associated with the greater economy, it must minimize company-specific uncertainties. Although the science is the key value driver in a life sciences company, investors need to see how the science will eventually translate into cash flow in the form of projections, and the level of certainty they have in those projections will ultimately determine the value they place on the company. Companies can increase the certainty in their projections by ensuring they are built up with sufficient detail and are based on reasonable, market-based assumptions. As many early-stage life sciences companies lack the internal resources to research and prepare detailed projections, such companies wishing to maximize their valuation need to partner with knowledgeable, reputable advisors to ensure that the projections are prepared with a level of diligence and care sufficient to assuage potential investors’ concerns over the quality of the projections and decrease their level of uncertainly.
Companies should also work to minimize operational uncertainties. Just as many early-stage life sciences companies lack the internal resources to research and prepare detailed projections, they may lack the internal resources to fulfill the financial reporting responsibilities that accompany pursuing outside capital and keeping investors appropriately apprised of the company’s financial position. Having appropriately prepared financial statements removes another potential uncertainty for investors and can help give them additional confidence in the company’s projections. Lastly, companies seeking to maximize their valuation should consider having an independent valuation completed by a valuation firm familiar with the complexities of valuing early-stage life sciences companies. Not only will such a valuation help management set reasonable value expectations as they seek to raise capital, but it can also help identify weaknesses that are limiting the company’s valuation and demonstrate to potential investors that management has done its due diligence.
About Centri Business Consulting, LLC
Centri Business Consulting provides the highest quality advisory consulting services to its clients by being reliable and responsive to their needs. Centri provides companies with the expertise they need to meet their reporting demands. Centri specializes in financial reporting, internal controls, technical accounting research, valuation, and CFO and HR advisory services for companies of various sizes and industries. From complex technical accounting transactions to monthly financial reporting, our professionals can offer any organization the specialized expertise and multilayered skillsets to ensure the project is completed timely and accurately.
For more information, please visit www.CentriConsulting.com
Eight Penn Center
1628 JFK Boulevard, Suite 500
Philadelphia, PA 19103
New York Office
530 Seventh Avenue
New York, NY 10018
50 Milk Street
Boston, MA 02109
Tysons Corner Office
1775 Tysons Blvd
Tysons, VA 22102
8310 South Valley Highway
Englewood, CO 80112